Posted by Tim Thompson CPA PLLC

Trading ETFs in a Turbulent Market

Trading ETFs in a Turbulent Market

Prices of securities in the past two months have gone haywire. One day stocks are crashing, the next day it’s zooming. There could be a bizarre dip of a low-risk bond fund in its price chart.

In these situations, you have the choice to hosed going into or out of a position. Let’s have a look at the below guide to trading carefully.

Exchange-traded funds, at least the big and actively traded ones, are priced at very close portfolio value and are very liquid in normal times. Your round-trip transaction cost on a $50,000 position could be as low as $10.

But you’re no longer in normal times. Let’s have a look at the Schwab TIPS ETF which holds a 42 Treasury Inflation-Protected Securities collection. It should be easy for market-makers to keep the ETF’s price tightly bound to the portfolio value since replicating that portfolio is easy. There’s a volume being seen in the neighborhood of 1 million shares on an average day based on the $8.6 billion funds. A $59 shares have a normal trading spread of two cents.

The price of this ordinarily stable fund, however, lurched down by 10% in March. The chaos is reflected by the widening of the spread on the fund by market-makers to 14 times in the norm, at one point in April: bid $58.87, ask $59.15. In that environment, a person who puts in a “market order,” in other words accepts whatever is on offer, will go towards the cleaners.

Utilize Limit Orders

Check the box that says you’re limited from paying to buy or the least you’ll accept to sell. You might have put in a buy order for 1,000 shares at $59.01 confronting that wide quote on SCHP.  The market maker would have been under no obligation to sell at the lower price you sought if he/she quotes the $59.15 asking price. A 1,000 shares, or none, or a partial fill might have been yours.

Patience Is Key

You probably shouldn’t chase a stock. If you didn’t get what you wanted right away, you can come back another day.

Luck will be on your side once the market quiets down which may actually happen sooner than we expected. Within days that the spread of 28-cent on SCHP shrank to two cents.

Don’t Let Orders Sit

You may not want to put a “good til cancelled” order because it will stay on its place for 30 to 90 days depending on the broker. The issue with a GTC is that a big move could be made by the market which may cause the bargain price to become a price that is rotten. 

What will you do if interest rates rise up overnight and this bond fun is supposed to be traded at $58.50 the next day? Obliging yourself to buy it at $59.01 is not a good idea.

Place Your Back against the Wind

Price and portfolio value may stay together pretty close, they do not move in lockstep. Depending on their order flow, market-makers set prices primarily in response to it. They only bring supply and demand into alignment when the price veers far off from portfolio value and by making or removing blocks of ETF shares.

Thus, it’s best for you to wait for a day when the price of the fund is down if you’re buying. That’s a sign that market-makers are seeing more sell compare to buy orders. ETF shares are probably priced by them at slightly less than portfolio value.

Watch Out for Hidden Spreads

The costs of trading go beyond the difference between the bid and that ask that is being displayed on your brokerage screen. They are also a volatility function.

Look closely at the SPDR Gold Shares (GLD). It’s a bullion fund that sees $2 billion a day in trading volume. It’s a minuscule spread that’s being quoted - usually just a penny on a $158 share. But every second, the price jumps around by a nickel.

Choose the Right Time

You may want to trade between 10 and 11:30 in the morning or between 2 and 3:30 in the afternoon. If you trade in the first half-hour, markets for the underlying stocks and bonds are just waking up. This only means market-makers in the ETF’s can’t hedge their bets that easily. So spreads are widened. Volatility, wide spreads, and poor execution happen during the final half-hour of the day. Lower volume happens in the middle of the day that’s why there is less liquidity.

Tim Thompson CPA PLLC
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